Hong Kong’s Office Shortage Spurs Makeovers of Factories

By Kelvin Wong -
Aug 12, 2013

Hong Kong investors are turning run-down factories and warehouses into offices to fill a space
shortage in the city with the world’s second-highest rents.

Pamfleet Group and Gaw Capital Partners are among real
estate funds that bought more than HK$54 billion ($7 billion) of
the city’s industrial properties in the year ended June 30,
according to data compiled by Centaline Property Agency Ltd.
That’s the highest for any 12-month period on record, the Hong
Kong-based realtor’s data shows.

Redevelopment of vacant industrial spaces has accelerated
since 2009 as investors lured by surging office rents seek to
exploit the gap between the cost of acquiring the buildings and
the potential return from converting them for use by banks,
insurers and other business tenants. The government has
implemented policy changes since the 1980s to encourage the
transformation of unused properties after manufacturing shifted
to cheaper locations in mainland China and Southeast Asia.

“It’s been a slow start, but things have picked up over
the past few years,” said Simon Lo, Hong Kong-based head of
Asia research at property broker Colliers International.
“Buyers are coming in with the expectation their returns will
go up multiple times because of the redevelopment potential.”

Demand for offices in Hong Kong has been swelling as the
city cemented its place as a regional financial hub over the
past decade. Average prime office rents have risen 54 percent to
June from mid-2009, according to government figures. Average
vacancy rates fell to 6.1 percent at the end of 2012 from 11.5
percent in 2009. Prime refers to the most stable high-income
producing properties.

Prices Tripled

The makeovers of industrial properties will provide about
800,000 square feet (74,300 square meters) of new office space
in Hong Kong next year, according to Colliers. Excluding
conversions, developers will add about 456,000 square feet of
new space in 2014, the broker said.

Increasing investor demand has pushed up prices of
warehouses and factories almost threefold since early 2009,
according to broker CBRE Group Inc. At the end of the second
quarter, warehouses fetched about HK$2,680 per square foot while
factories were getting HK$3,540 per square foot. Higher prices
drove down the average investment yield to below 3 percent at
the end of June, Colliers said.

By contrast, prices of prime offices in Central have
doubled to more than HK$35,000 a square foot in the first half,
according to government figures. Yields have fallen to about 2.8
percent, according to Colliers.

Rising Rents

Goodman Group, (GMG) whose funds own about 40 percent of Hong
Kong’s prime warehouse space, is taking advantage of rising
values to exit some properties. In the past year it has sold
some of its older and smaller assets to buyers that plan to
convert them for office use, said Philip Pearce, Greater China
managing director of the Sydney-based company.

“What we have been able to do is redeploy that money to
other acquisitions and upgrade existing properties,” Pearce
said in an interview in Hong Kong. “And when you’ve taken
supply out of the market, it clearly has an impact” on rents,
he said.

Monthly rents for logistics buildings climbed to HK$8.80
per square foot at the end of June and reached HK$9.50 per
square foot for factory space, CBRE said. Both have risen about
80 percent since 2009.

Prime office rents in the Central business district, where
HSBC Holdings Plc and Goldman Sachs Group Inc. have their
regional headquarters, were the highest in the world after
London’s West End at the end of 2012, according to broker
Cushman & Wakefield Inc.

Kowloon East

Central’s average monthly office rent fell 1 percent to
HK$103.30 a square foot in the first half of 2013 as banks and
brokers sought cheaper locations to cut costs, the New York-based Cushman said. Rents in Kowloon East rose 7.2 percent to
HK$32.60 per square foot, while in Kowloon West, another area of
office towers converted from industrial buildings, they
increased 6.7 percent to HK$41.30 a square foot.

The average office vacancy rate across Hong Kong stood at
4.6 percent at the end of June, compared with 4 percent at the
end of 2012, according to Cushman.

“When rents were fairly similar, it didn’t really make
sense for someone to go and buy an industrial building and
change it into an office,” said Darren Benson, Hong Kong-based
senior director for industrial and logistics services at CBRE.
“In the last 12 months, investors were just piling in. The
revitalization is really driving the market.”

Hong Kong-based Pamfleet and Swiss private-equity fund
Partners Group in April completed a HK$958 million acquisition
of a 13-year-old factory building in Kowloon East, one of the
city’s oldest industrial areas, which has been designated by the
government as a secondary business district.

Gaw Capital

The building is within walking distance from the 21-story,
1.1 million square-foot Manulife Financial Centre developed by
Sun Hung Kai Properties Ltd. (16), Hong Kong’s biggest builder by
market value, and Henderson Land Development Co. on an old
industrial site in 2007. Pamfleet will convert the project into
an office tower that can be opened to tenants as early as the
end of 2013, Chief Executive Officer Andrew Moore said in an
interview.

Gaw Capital in January paid HK$950 million for an
industrial building in Kowloon East with a gross floor area of
about 195,500 square feet, with an aim of turning it into a
hotel or office building, according to Kenneth Gaw, a co-founder
of the Hong Kong-based fund.

Pioneer Global Group, its sister company, is converting an
additional 230,000-square-foot industrial building into office
use in the same area, Gaw said.

Space Shortage

New office supply in Hong Kong will fall about a third
short of demand by 2020, according to CBRE. To tackle the space
shortage, the government has pledged to develop Kowloon East,
which includes the abandoned Kai Tak airport site, into a
secondary financial district with more than 40 million square
feet of prime-office space. An estimated 88 percent of the 1,500
industrial buildings in Hong Kong are eligible for conversion
under the government’s plan, according to Colliers. “We
have a supply side problem with reasonably strong demand,” said
Pamfleet’s Moore, referring to a 3 percent vacancy rate among
prime Kowloon East office buildings. “This is an incredibly
popular district these days.”

Manulife Financial Corp. (MFC), Canada’s biggest insurer, in
April agreed to buy a 512,000-square-foot tower in the Kowloon
East for HK$4.5 billion, the second-highest price paid for an
office building in the city. The insurer will use it as its
headquarters in the city upon completion in 2015.

The pace of transactions of industrial properties will
probably slow in the rest of the year before picking up again
because of the government’s attempts to quell concerns of a real
estate bubble, according to Centaline.

Entrepreneurs Influx

The Hong Kong government in February doubled stamp duty
taxes on all real estate deals, the first time such measures
were extended beyond residential properties.

“Investors will need time to adjust to the new tax,”
Stanley Poon, chief operating officer at the commercial property
arm of Centaline, said. “Things will probably pick up towards
the end of the year when sellers become more willing to
negotiate.”

An influx of entrepreneurs -- many of them escaping
Communist Party rule -- from Chinese cities, such as Shanghai
and Tianjin, in the 1950s, contributed to a boom in the
manufacturing industry in Hong Kong, then a British colony.

By 1980, with low local wages, more than 44,000 factories
sprung up and the number of workers ballooned to almost one
million, according to government figures.

Relaxing Rules

Those numbers declined as wages and rents increased,
drawing manufacturing to cheaper neighbors including Malaysia
and the Philippines. In 2008, there were 12,000 factories in
Hong Kong and 142,000 workers. Manufacturing accounted for 2.5
percent of the city’s economy in 2010.

As demand for these spaces started to wane in the late
1980s, the government began relaxing rules on industrial-property usage, gradually raising the amount of space that can
be used for offices and showrooms in the buildings. In 2001, it
turned about 22 hectares (54 acres) of industrial land in
Kowloon East to commercial use.

“It took a long while for anything to really happen,”
CBRE’s Benson said. “But now, the policies, the liquidity in
the market, investors and speculators have really driven up
prices in these areas.”